Subtle Price Discrimination and Surplus Extraction Under Uncertainty

15 Pages Posted: 26 May 2009 Last revised: 24 May 2013

See all articles by Eduardo Zambrano

Eduardo Zambrano

California State Polytechnic University, San Luis Obispo - Economics

Date Written: March 31, 2013

Abstract

In this paper I provide a solution to Proebsting’s Paradox, an argument that appears to show that the investment rule known as the Kelly criterion can lead a decision maker to invest a higher fraction of his wealth the more unfavorable the odds he faces are and, as a consequence, risk an arbitrarily high proportion of his wealth on the outcome of a single event. I show that a large class of investment criteria, including ’fractional Kelly,’ also suffer from the same shortcoming and adapt ideas from the literature on price discrimination and surplus extraction to explain why this is so. I also derive a new criterion, dubbed the doubly conservative criterion, that is immune to the problem identified above. Immunity stems from the investor’s attitudes towards capital preservation and from him becoming rapidly pessimistic about his chances of winning the better odds he is offered.

Keywords: Kelly criterion, risk management, asset allocation, betting rules, price discrimination, expected utility theory

JEL Classification: D11, D81

Suggested Citation

Zambrano, Eduardo, Subtle Price Discrimination and Surplus Extraction Under Uncertainty (March 31, 2013). Available at SSRN: https://ssrn.com/abstract=1409843 or http://dx.doi.org/10.2139/ssrn.1409843

Eduardo Zambrano (Contact Author)

California State Polytechnic University, San Luis Obispo - Economics ( email )

Orfalea College of Business
San Luis Obispo, CA 93407
United States
805-756-5327 (Phone)
805-756-1473 (Fax)

HOME PAGE: http://calpoly.edu/~ezambran

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